Fed to outline bank commodity policy early 2014 -source

By Douwe Miedema and David Sheppard

WASHINGTON/LONDON, Oct 28 (Reuters) - The U.S. Federal Reserve may not unveil its plans for regulating Wall Street's commodity trading business until early next year, a person briefed on the matter said, deferring a decision on the politically fraught debate into 2014.

The timing confounds any expectations that the regulator would make its views known before a second Senate hearing expected next month into the rigging of aluminum and other markets, at which Fed officials are due to testify.

"I was told ... they would not make any determination by the end of the year, but maybe soon after that," the person said, asking not to be named because the talks were private.

A spokeswoman for the Fed declined to comment.

The Fed is reviewing a decade-old decision that has allowed Citigroup, Barclays and other banks to engage in the trading of physical commodities such as oil and metals, as well as its wider policy on containing the risks from the commodity business for banks. It has never publicly set a time frame or deadline for the review.

The new scrutiny of Wall Street's multibillion-dollar raw material trading operations has unsettled banks, which fear the Fed may impose new constraints on a business that has already lost much of its luster and higher regulatory costs.

In July, JPMorgan Chase & Co. announced it was putting its physical commodity desk up for sale.

One core concern the Fed may have is the potential peril to a bank's health from owning physical commodity assets such as oil tankers and drilling platforms, lawyers said, including litigation, contractual or criminal risk.

"The Fed is looking at the safety and soundness (of the banks), and litigation risk is one aspect of that. They will determine ... whether capital and other prudential controls properly address it," said Karen Shaw Petrou, a co-founder of Federal Financial Analytics, a consultancy firm.

The Fed may look at higher capital requirements for banks exposed to the physical commodity business, lawyers said, and the law gives it ample leeway to adjust the rules and tell banks in more detail how to run the businesses.

"They've got a lot of discretion in that area," said one banking lawyer in Washington, asking not to be named in order to speak more freely. "Anywhere from suggesting you need more capital ... to requiring other procedural protections or risk management to be put in place."

NO FUNDAMENTAL OVERHAUL

The issue of banks' decade-long expansion into commodities hit the mainstream this summer after big aluminum buyers represented by MillerCoors - the second largest U.S. brewer - complained in a Senate hearing that some banks drove up costs through their control of metal warehouses.

The Senate Banking Committee hearing was lead by Sherrod Brown, an Ohio Democrat who is canvassing for a bill for banks to hold far more capital, a measure that could trigger the break-up of the largest Wall Street firms.

However, in examining banks' commodity business the Fed is unlikely to concern itself with market manipulation, lawyers have said, something that is the remit of two other regulators, the Commodity Futures Trading Commission (CFTC) and the Federal Energy Regulatory Commission (FERC).

There also may be little the Fed can do about the fact that Morgan Stanley and Goldman Sachs have far wider leeway to operate in commodity markets than their rivals, because of a quirk in the banking law.

"They may reconsider some of their orders, but they won't seek a change in the law," the person said.

The two banks sought refuge with the Fed at the height of the financial crisis by changing their status to bank holding companies, and the move enabled them to use a grandfathering clause for their commodity activities.

The law allows investment banks who changed their status to bank holding company after 1999 to keep any activities they already engaged in, a provision written into the law to encourage banks to come under the Fed's wings.

Morgan Stanley and Goldman Sachs are now the only two major Wall Street banks benefiting from that authority to not only own, but also transport, store, distribute and refine commodities, something that the other banks cannot do.

Other investment banks may be allowed to own physical commodity assets like power plants or oil terminals as so-called merchant banking investments, lawyers said, which could offer better protection from legal risk.

Merchant banking investments need to be sold after a period of 10 years, however, and there are strict limits on how closely the banks can be involved in running these businesses.